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Somewhat Less Assured

There once was a market in thrall
To central banks who overall
Had fueled the craze
For three thousand days
Preventing an equity fall

But recently views have matured
With traders somewhat less assured
The future will be
So calm and risk-free
Especially those unsecured

For the second day running, the dollar is broadly higher, although the movement has not been sufficient to come close to unwinding its early weakness this year. But what is more interesting to me is the fact that so many stories that I have been reading are focused on the idea that we may have seen a top, even a temporary one, to recent market moves.

Certainly, it would be fair to characterize some aspects of market behavior as mania-like (maniacal?), naturally starting with the cryptocurrency sphere, but also with the idea that changing the name of a company to include ‘blockchain’ is worth a 100% or 500% gain in the value of that company. The fact that stories continue to be told of people who gave up their day jobs to become Bitcoin traders or short volatility traders certainly reminds me of the run-up to the tech bubble, where equity day trading played a similar role. Or perhaps, of more recent vintage, was the house-flipping we saw in the run-up to the financial crisis nearly ten years ago, the very situation that started the new party on the back of central bank extraordinary monetary policy.

Most of you know that I have been somewhat skeptical that the extraordinary gains we have seen across markets will continue, recognizing that they cannot go on forever. And I have repeatedly said there doesn’t actually need to be a definitive catalyst to change views. Markets can be quite perverse, and there will be no announcement that the top has been achieved. But one thing of which I am pretty sure is that the more stories written about this particular subject, the more likely it will be a self-fulfilling prophecy. For the newer market entrant, the combination of an increase in warnings and the lack of new gains in your portfolio could easily be sufficient to cause a change of heart. Although, history shows that they will wait until they are much further under water before acting. At the very least, the idea of a more significant correction getting underway is quite viable, so be nimble.

But back to the FX market. Certainly part and parcel of the narrative of late has been the dollar’s weakness, which last year added up to a nearly 11% decline vs. its major counterparts. Almost every analyst call for 2018 has been for a continuation of that move, with some calling for another 15%-20%. I strongly disagree with that idea, and wouldn’t be surprised if we have already put in the bottom for the dollar this year. From a historic perspective, there have been numerous years (e.g. 2015) where the previous year’s trend reversed early on amid expectations of a continuation. And as I look at the fundamentals, notably monetary policy issues, I continue to see the Fed as the most likely to be more aggressive than expected and the dollar to benefit accordingly.

Early this morning the Eurozone data reconfirmed that there is no inflationary impulse yet on the Continent as the core CPI remained at 0.9%. Simultaneously, we got our first ‘dovish’ commentary from an ECB member in what seems like a year, when Vitor Constancio basically called into question the euro’s recent strength saying, “I am concerned about sudden movements which don’t reflect changes in the fundamentals. Looking at fundamentals, inflation declined slightly in December.” Of course, the market trades on the narrative, which anticipates the future fundamentals, but as I have said repeatedly, it would be very surprising if Signor Draghi turned hawkish at next week’s ECB meeting. Meanwhile, Dallas Fed President, Robert Kaplan, was out talking about the probability that we could see more than the three Fed hikes currently forecast for this year. Certainly that combination is worth a little dollar strength!

The point is, for the first two weeks of the year, we have seen an acceleration in the trends that held for last year, with equities exploding higher and the dollar falling broadly. If nothing else, my sense is things are overdone in the short run and that a correction, long overdue, may be coming soon. For all of you receivables hedgers, these are the best levels we have seen in three years and I would be keen to take advantage.

On the data front, IP (exp 0.5%) and Capacity Utilization (77.4%) are released this morning and then the Fed’s Beige Book comes out at 2:00pm. There has been nothing to suggest that the US economy is slowing down and I expect this data to reconfirm the recent trend. We also will hear more from Kaplan as well as Charles Evans and Loretta Mester, so watch the tape this afternoon. But from that crew, I expect a more hawkish bent, which means the dollar should behave well. While equity futures are pointing higher, that was yesterday’s story as well, right up until they tanked. All I’m saying is that change is coming, and it feels like we are beginning to see it more clearly.